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Readers, take a look at the following quote from Decisive by Chip and Dan Heath:

Imagine walking into a courtroom where the trial consists of a prosecutor presenting PowerPoint slides. In 20 pretty compelling charts, he demonstrates why the defendant is guilty. The judge then challenges some of the facts of the presentation, but the prosecutor has a good answer to every objection. So the judge decides, and the accused man is sentenced.That wouldn’t be due process, right? So if you would find this process shocking in a courtroom, why is it acceptable when you make an investment decision?

This courtroom analogy for investing is incredibly helpful, and it offers us a couple of useful insights.

First, it’s a window into how most people invest. They more or less form a decision first, then amass facts to support it, and then--if they’re lucky--they might challenge a few minor facts, mainly to satisfy their ego’s need to be viewed as a judicious decision-maker. Not unlike the pseudo-judiciousness in the “20 pretty compelling charts” example above.[1]

Second, this quote indirectly teaches one of the key secrets to investing, and it’s this: you must be able to argue both sides of any decision such that the arguments are equally compelling. You simply must. You want to buy XYZ stock? Make a list of the reasons why, record them in your investing journal, and then make an even longer list of reasons why not to buy XYZ stock.

And if you can’t come up with that many reasons, you’re not trying hard enough.

Use this exercise at every stage of your investment decision-making. Which sector of the stock market (dividend-paying consumer products stocks, technology stocks, industrial stocks, etc.) would I like to invest in? Should I invest in individual stocks or low-fee index funds? Or, more foundationally: should I invest in the stock market at all? Make a list of reasons why, and a longer list of reasons why not.

Why does this technique work? Two reasons. First, when good reasons to own a stock are known, those reasons are generally already accounted for in the price. And second, when it seems like a bad time to invest in stocks, it usually isn’t.[2]

Which brings us to another important insight. There’s never an all-clear sign for any specific stock market decision. The coast is never clear.

Wait, I take that back! I can think of two examples when the coast was clear.

The coast was “clear” for owning tech stocks back in late 1999/early 2000. And the coast was “clear” for owning single family homes and residential real estate in 2006/2007. Both of those investment themes worked out great, didn’t they?

Didn’t they?

Money coming out of the wazoo
Once again, it’s not just that investments tend to work out badly when the coast seems clear. It’s also that investments work out well when the reasons against them are both known and properly feared. When everybody’s a fan of, say, tech stocks, everybody will already be invested in them. When everyone’s already in these stocks, who’s left to buy? Likewise: if everybody hates tech stocks (say in mid-2002 when revulsion against the sector was at all-time highs and prices were at lows) only a few brave contrary thinkers were invested in the sector.

Who do you think's going to have good investment results here?

All of this tells you something extraordinarily valuable about investing. If you don't want the stock market to separate you from your money, you have to talk to people. You have to get a sense of what people are doing, where their thinking is. Readers of a certain age should be able to remember the craziness of the waning days of the late 90s when there were constant discount brokerage ads on TV featuring characters like tow-truck drivers so wealthy from daytrading that they could buy their own islands. Back then, when nearly everybody was talking about the tech stocks they owned, ads with slogans like “he’s got money coming out of the wazoo” were widely seen as funny. Or worse, true.

Today, they are cringe-worthy. Horrendous.

When your barber and tow-truck driver and most of your friends and neighbors are daytrading their accounts and they can’t shut up about it, that’s a warning. A big one.

Interestingly, right now, not all that many people are talking all that much about stock market investing.

Who’s on the other side of your trade?
Let’s tie all this back to our concept of arguing both sides of an investment decision. If you are so brilliant to arrive at a decision to buy a stock, and if that decision to buy is so airtight and ego-satisfying (think back on those 20 pretty compelling charts), why would anybody sell it to you? Obviously, somebody has to sell to you or there’d be no stock for sale in the first place.

So what about that guy, the one taking the other side of your trade? What's he thinking?

Roll this idea over in your mind for a moment. Do you really think you’re smarter than that guy?[3] Stroll down this avenue of inquiry even for just a few minutes and it quickly makes you very, very humble about being right. Even if you have a stack of PowerPoint slides justifying your position.

I’ll close with one final thought. Think of the universe as containing two taxonomies of information:

1) Facts that support your opinion2) Facts that do not support your opinion

Cultivate the ability to seek the second of these two items and you will go very far as an investor.

Footnotes: [1] Many of you reading probably think you don't do this. And you certainly wouldn't be the kind of person who gets played by your ego into settling for "pseudo-judiciousness." Except you do. We all do. And professional investors do this too--in fact they’re often the worst offenders precisely because they think they’re above doing it. There’s a huge insight right there about why investors must cultivate humility to be successful.

[3] Warren Buffett had an even better expression for this: “If you've been playing poker for half an hour and you still don't know who the patsy is, you're the patsy.”

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